Buy or Rent: The One Number you Need to Look at

Kiplinger recently ran an article that shed some really great light on whether it makes more sense to buy a home or rent an apartment. I’ve never addressed this topic on 20somethingfinance, because quite frankly in the housing market that we’ve had over the last two years, it’s hard to make a strong case for buying a home. That’s coming from someone who’s last two dwellings have been purchased homes.

Buying Versus Renting: First Look at the Price-Rent Ratio

Kiplinger suggests looking at the median price of a home versus the median annual price of rent, otherwise known as the price-rent ratio, when deciding whether to buy or rent.

At the housing market’s peak (in 2005), the national median home price had inflated to 21 times the median annual rent. However, in the second half of 2009, that ratio dropped back down to 15, which is the historical norm. That indicates a national housing bubble.

Price to Rent at the Local Level

That’s all fine and dandy, but how does that affect you at the local level?

Kiplinger claims that if the price-rent ratio where you’re looking to buy is 18 or higher, your market might still be over-priced, and the odds are that prices could fall further after you buy. If it’s fallen below 15, odds are pretty good that they won’t fall further.

Home Prices Versus Apartment Rental in 20 Metro Areas

The following chart looks at the price-rent ratio in some of the nation’s largest metro areas. The monthly mortgage payment shown is based on a 30-year fixed rate mortgage with a 10% down payment and 5.3% interest rate). The apartment rent price is the median rent price.

Looking at the chart, it might make a whole lot of sense to buy a home if you live in Cleveland, but probably no sense at all if you live in, well…. just about anywhere in California.

How Do you Determine Rent or Buy Even More Precisely in your Area?

What you can do is get an average list price of homes that satisfy what you would be looking for and then divide that by the average annual rent of similar apartments in the area. Pretty simple stuff, right?

Why I love this Home Buying Advice

Determining when to buy a home based on your speculation of whether the home price will go up or down is much like trying to time the stock market. Everyone has their guess on where prices are heading, but nobody truly knows. Home pricing, however, has a large component of material value, making it much more concrete than stocks.

Using the price-rent ratio is brilliant in that it takes the guessing out of the equation. Just look at the cold hard numbers and let them make the decision for you. You could also use this when determining when to sell a home (if the price-rent ratio gets outrageously high).

Buy or Rent Discussion:

Have you ever looked at the price-rent ratio when deciding whether to buy a home or rent an apartment?

Do you live in one of the 20 metro areas highlighted? Which one? Do you think prices will go up or down in your area?

My husband and I did not look at the price-rent ratio exactly when we decided to buy a home, but we did look at how much more a house would cost us a year.

Rent was costing us $8760 a year and was increasing 5-10% a year at the end of each lease…it was driving me nuts.

Our home cost us $24,000 up front (20% down and closing costs) and costs about $15,000 a year including taxes, insurance, and maintenance for 11 years. After the end of 2017, we’ll only need about $4500 a year for taxes, insurance, and maintenance plus a 3% increase each year (even though our taxes have decreased since we bought our house, this was how I calculated it in 2007).

That meant that with a 5% increase every year on rent and a 3% tax increase every year on property taxes, we would be breaking even with home ownership in less than 20 years plus we would own a home outright in about 11 years. In less than 20 years of renting, we would have paid just as much and have no physical thing to show for it. That alone would have convinced me to buy in our area.

We live on Houston, TX, which isn’t on the lists above, but has a price-rent ratio of 15.77 if you divide its median home price of $163,692 by its median rent of $865 a month ($10,380 annual total).

I know that this is an ongoing debate that will likely never be ended. It really depends on your personal preference in most cases. As you can see from the comment of Budgeting in the Fun Stuff it will take them 20 years to get to the breakeven point on buying their home. If you’re planning on staying in the same area for the rest of your life (or at least for the next 5-10 years) then buying could make more sense. However, many young people change jobs frequently and are much more mobile now than at any time in the past. For these people it makes much greater sense to rent.

Much of the decision to buy vs rent is psychological, at least it seems that way to me when reading about others decisions. More space, able to make it your own, a place to call home, etc.

In the end it’s always a personal decision, but I believe in many cases you can do better renting and investing the difference, especially when house prices are so high compared to rental costs.

“Budgeting in the Fun Stuf” , thank you for putting this into perspective (good post!). I also agree with “Money Infant” with regards to the psychological factor.

I work in NYC and have been renting all my life. I have saved up $150,000 and have been looking for house for over 2 years in the nearby suburbs with my maximum price of $350,000 (which will get you a decent 2 bedroom 2 bath starter home). Even after the housing crisis last year, prices are still high in my area. There are some foreclosure deals but I would not want to live in those areas. Another problem is property taxes ($8,000 to $11,000 in decent middle class areas).

I’m still looking but after witnessing the torrential rains we had this past weekend, hundreds of down trees, no power for over 5 days, and the massive flooding in major parts of the NYC area…..I told my wife the peace of mind we have as being renters in an apartment building.

Maybe if lived in Dallas where you can get a great house for $150K, I wouldn’t think twice, but you have to evaluate all the pros and cons of home ownership.

Salman, I completely agree. If we lived in a different area and the numbers were different, we’d rent too! I was just showing how we reached our decision here in Houston. Thanks for the compliment on the post! I spend way too much time blogging, but I appreciate when my comments get noticed.

Seth that is a good question. I have also looked at Condos but a majority of my friends (who used to be former Condo owners) quickly got tired of them due to the rising maintenance fees.

If the building is especially old, then those fees can creep up to a major monthly amount. There is a development in my area that has 2 bedroom 2 bath condos for $139K………but the maintenance fees are $1150 per month….and go up every year.

Most houses built in the 80s or after is so shoddily constructed that people will pay off their houses right before they are condemned. My boyfriend and I are renting a condo right now (built in 1983) and it is SO POORLY BUILT that I feel sorry for anyone in the complex that owns one – even the owner/landlord of ours is making things worse by deferring some fairly significant maintenance/replacement projects (and to make matters worse for them, we are renting for less than the cost of the mortgage because she was so desperate to get a renter in this economy – we live in Phoenix where the housing market collapsed so completely she probably couldn’t have sold it at all).

I don’t look at the rent ratio per se, but I do look at whether I can cover my mortgage with the going rent. I don’t want to be in a situation where I can’t afford to move out of my house.

I live in Las Vegas and home prices have dropped by as much at 75%. I just purchased a home for $53,000 that sold for about $200,000 three years ago. It’s a very nice 3 bed on .08 acres and didn’t need much more than paint and carpets.

Prices here have pretty much bottomed out, but are still slowly creeping down. I think it is going to be several years before we can profit by selling. However, with a mortgage payment of less than $400 and neighborhood rents going for $850 it still makes sense to buy this property rather than continuing to rent. In fact, so many investors are hip to this fact that almost every house listed has multiple competing cash offers. There are now “investment tours” where foreign investors ride on buses to view properties for sale. It’s a great opportunity for a first time home buyer to get into a home at the bottom of the market.

However, that said, there is a lot more to owning a home than just the mortgage payment. Liability, repairs and maintenance will eat up your money, free time and peace of mind unless you love working on your house. It’s not for everyone.

That is great that you took advantage of renting for a while to save up! Smart move. The only problem with buying now is that you have to be an A+++++++ buyer. Anyone with even the slightest blemish on their credit report may find themselves in a jam. After the whole sub prime fiasco, it became a little more difficult to obtain a mortgage. For those people, now is an optimum time to rent and fix up their credit!

Guys, the number one reason to buy RE as an investment is to take advantage of leverage. No other asset class allows for the utilization of leverage by the common investor. 20% down = 5 to 1 leverage; 10% down = 10 to 1 leverage; 5% down = 20 to 1 leverage. That means for every 1% of home value increase, you return 20% on your invested capital.

Of course this works the same way when prices fall, so it’s important to properly understand and assess the risk involved with the levered position.

Of course, this doesn’t take into account the other reasons to own your home (security, customization, pride of ownership, etc), but leverage is really the main reason to invest in real estate.

Due to an unexpected job transfer in 1997, I sold my first house after owning it for five years. After three months of having the house listed, I got exactly one offer at 98% of list price. After all closing costs and repairs and improvements over the five years, I broke even (but, of course, I lived in the place for five years). I sold the place at a Price/Annual Rent ratio of 9.

I happily rented a series of nice apartments for the next fourteen years (but spent $126K in rent!). The dramatic drop in housing prices over the past few years enticed me back into the idea of home ownership, and in Sep. 2011 I purchased a nice 2000 sq ft 3/2/2 on a Florida golf course, four miles from the Atlantic Ocean, 1.5 miles from my job at a Price/Annual Rent ratio of a whopping 5!